The Madness of Investors

Before the company had launched even a single product, Color raised $41 million from investors. That seems, to me, an absolutely stupefying amount of money. Given that Color’s first product (a perplexing and unfathomable iPhone app) flopped horribly, it seems now like an incredibly grave error.

It all stems (the NY Times speculates) from a desire not to miss out on the next Facebook, or Twitter, or Google. That’s all well and good, but in some ways this amounts to a get rich scheme; if it was that easy to pick out the next winners from the next losers, then everyone would be doing it, and we’d all get rich.

In pursuit of easy money, they’re taking unconscionable risks. It feels like many of the bubbles of old; presumably what they’re hoping for is to fund a lot of companies, and then hope that the return on the investment is of such Facebookian proportions that it drowns the losses. It’s madness, because if that scale of success doesn’t materialise, you lose the money.

Finance is, essentially, a utility. The function of it is move money from places where it is in surplus to where it is needed. As always, I grasp towards a physics analogy: it’s supposed to move the market from a higher energy state, to a lower energy state through a path that would otherwise be low probability. In doing so, it allows work in the system; jobs created, products made. The finance industry, for its part, takes a small amount of the energy it releases for itself. Overall, the system, the market, the economy, is better off for the action.

The trouble is that the financial sector has given itself airs. They see themselves now as creators, and players in the system in their own right, rather than the facilitators and plumbers that they should be. So they take risks, play the system, create complicated schemes of financial instruments to manipulate the market to accrue money into their own hands.

The trouble with all of this is that banks can then create situations where they actually help to destroy value. We saw this sort of reckless stupidity in the credit crunch, and we see it here, too.

What we should be doing is encouraging companies to start small, and bootstrap themselves. Make a product, sell a product, make money. Use the money to grow. Take finance where you need it, but only when you need it to make more money, where a return is unlikely. Controlled, steady, sensible growth.

What banks seem to want is growth like an algal bloom, or an infection of smallpox. Big bang growth, get-rich-or-die-trying growth. Short-termist, irresponsible, madness.

I’m honestly a little surprised that the financial industry has survived the last recession relatively unscathed, and apparently with their ways throughly unmended. These people ought to be legally responsible for the harm they do, in the same way a plumber would be responsible for an explosion caused by a botched gas installation. Instead we let them get away with wreaking the most awful harm on our economies, and ruining lives.

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In other news, I’m going to try and make a commitment to updating on a more regular schedule, and hopefully being a little more personal with it. Had a bit of a trend to the essayist in recent(ish) posts, so I’m going to steer away from it.

Basically, the problem is that I’m either working or I should be working on my PhD most of the time, so blogging has taken it in the neck. Haven’t even finished my new blog design yet…

You point out that the function of the finance industry is to “move money from places where it is in surplus to where it is needed”. And yes, that’s certainly one of the functions of the finance industry.

And to bemoan the fact that they’re not doing this properly, you’ve given the example of, er, the finance industry moving money – $41million worth (which, whilst not a drop in the ocean, isn’t exactly a colossal amount) – from a place where it was in surplus, to a small company who needed it to develop. I’m afraid I really don’t follow your logic on that one…

It’s correct to point out that it may be a risky investment (although so is any investment, to vary degrees). But then, why do we care? It’s not our money, and if someone wants to throw $41 million of their capital at an unproven startup, then, brilliant (and if any such people read this, please get in touch as I have a couple of ideas for you to throw money at!). Because by testing that startup’s ideas, by getting a product to market and seeing if it’s any good, by experimenting in this manner, we might just end up with something brilliant.

This is generally seen as a good thing. I mean, venture capitalists (which is what we’re talking about; not the same as banks, don’t confuse the two) once invested in companies as risky as Apple, Microsoft, Intel, Google…

Yep, the whole thing could go titsup and the VC loses their money. In which case, we don’t care. No more than we’d care if some random stranger walks into a casino, plonks $41 million on black, and the ball lands on red. It’s not our money. To use your analogy, it’s not that the dodgy boiler explodes, more that it just ceases to be.

And no, we didn’t see this sort of reckless stupidity in the credit crunch. The credit crunch was caused by a whole host of things that were magnificently more stupid than this, and not just on the behalf of the finance industry. Really rather debatable as to whether they’ve come out of it all unscathed too, especially given current and recent events (although actually, thanks to the munificence of institutions like the ECB, it’s probably not an unfair characterisation. Which is absolutely astounding if you think about it; you should write an angry blog about that!), but I guess we’ll wait and see on that one.

The point I was making is that utilities are supposed to operate responsibly; i’m happy if the water company pumps water into my home. I’m less happy if they ramp the pressure up to high and a pipe bursts and floods my house.

I agree that’s a somewhat strained metaphor, but that’s the sort of point i’m going for.

This sort of behaviour bothers me because it produces the impression of growth; it makes it look like jobs are being created, companies with high valuations appear, etc. but it’s all essentially illusory, and will implode. Having the impression of a boom is dangerous, because people (and governments, alas, are also people) will tend to behave accordingly.

As i’ve said before, I think almost everyone has had a hand in the last crisis, and it disturbs me that almost nobody seems to have learned any lessons at all.

The diffence between companies like Apple, Google etc. and Color is scale. Their investors want to start, from scratch, a company that can take on Facebook and win. They’re mad. Facebook didn’t start enormous, nor did Apple. Apple started with just the two Steves building computers in a garage, for instance. We all know the (albeit fictionalised!) story of Facebook. It’s sane to start small, and build your way out from there, making money from day one if you can, not spending money from day one.

This sort of thing is especially a problem in the tech industry, ’cause people build companies just for the purpose of getting acquired by one of the giants, rather than to be profitable enterprises in their own right.

But they aren’t utilities. It isn’t banks making those investments, it’s venture capitalists. Big whopping difference.

And I agree, the example you quoted isn’t particularly sane, and nor is the general social networking bubble at the moment. But for those who haven’t invested in those businesses, it’s not really an issue. It’s very different to the credit crunch, where the riskiness was (deliberately!) shifted around the system and hidden.

Like I said, if you want to get angry about something, be angry about how Greece or Ireland are being/have been treated by the ECB et al. Naked self-interest (mostly from governments) being put before what’s best for those countries. It’s disgraceful.